When you are young, the road to a secure retirement—buying a home, saving for your kids’ college education—might seem impossibly long.
It all begins with putting a bit of your hard-earned cash into a nest egg. Keep saving every month and you’ll be on your way to reaching your financial goals.
How to start investing: An overview
At its heart, investing means putting money into financial securities, such as stocks and bonds, with the expectation that the money will grow in the future. This growth can provide income and can help offset some risks, such as inflation, which makes today’s dollar worth less in the future.
For example, a simple bank savings account is a “safe” type of investing, but at today’s low interest rates, your nest egg won’t grow fast enough to stay ahead of inflation. By contrast, money invested in the stock market since 1926 has grown 10 percent on average every year, far outpacing inflation. However, money invested in the stock market can lose money over the short term, making it best suited for your long-term investments.
Why you need to start investing
Medicare and Social Security aren’t enough to live on when you retire—Social Security checks only cover 38 percent of the average retiree’s living costs, according to the government. You’ll still have out-of-pocket medical expenses, such as dental care and nursing homes, and so you need to invest on your own to make up the difference between your costs in retirement and what benefits the government provides.
The best strategy is to start investing when you’re young, to take advantage of compound interest, which over time will multiply your savings exponentially. That said, retirement is the last thing that most young people want to think about, so it can be hard to get motivated to save. Fortunately, the government and your employer have made it easy to get started.
Investing on autopilot
Chances are your employer offers tax-free investing in a 401(k) or similar plan. Congress authorized these plans to encourage retirement investing. When you sign up for these plans, money is taken out of your paycheck automatically, before taxes. The money then grows tax-free in the account before you withdraw it when you retire (you will pay regular income taxes on withdrawal.) To jumpstart participation in these plans, many companies offer matching contributions up to a certain percentage of your pay. In 2018, you can stash up to $18,500 annually from your pay into a 401(k), not including employer matches.
How much will money in a 401(k) grow?
That depends on many unknowns, including pay raises and the performance of the stock market. But consider this scenario: over a 30-year career in which you invest the maximum each year and take advantage of typical employer matching of up to 3 percent of your pay, you might personally contribute $692,000—and retire with more than $3 million.
What if I don’t have a 401(k)?
If your employer doesn’t offer a 401(k), you can invest in an Individual Retirement Account (IRA), which works in much the same way: you won’t pay taxes on your contributions, but your withdrawals will be taxed. A Roth IRA is funded with taxable income but grows tax-free and is not taxed at withdrawal. The IRA contribution limit for 2018 is $5,500. You can set one up at brokerage firms, and even arrange automatic monthly payments.